Lynn Tilton allegedly exploited large losses at certain Zohar portfolio companies in order to reduce or avoid personal income taxes, even as she was funneling out tens of millions of dollars per year in income for herself, according to documents filed in a fraud case brought in New York by two German banks.

Papers filed late Friday (8 September) show that a proposed civil amended complaint from the banks – Norddeutsche Landesbank and Hannover Funding Company – heavily references the allegation that Tilton incorporated income losses at the Zohar portfolio companies into her own personal tax filings, thereby reducing her tax burden. As part of a dispute about what should be redacted in the amended complaint, some of the redacted material appeared in documents filed publicly with the court by Tilton's lawyers.

This use of Zohar company losses in personal filings was happening even as Tilton was siphoning out tens of millions of dollars each year in the form of agency and management fees as well as preferred equity distributions, the complaint says.

“By misrepresenting to the IRS that the Portfolio Companies were an agreed-upon part of the ‘Tilton Enterprise,’ Tilton aggregated the profits and losses of all of those Companies with her own income from, among other sources, Zohar Fund collateral management fees and management and agency fees charged to the Portfolio Companies,” the complaint reads.

“The result? Even though Tilton made tens of millions of dollars each year from Zohar Fund and Portfolio Company fees, as well as from misappropriated distributions made by the Portfolio Companies, the huge operating losses of those Companies wiped out virtually all of her tax liabilities,” the complaint goes on.

The German banks on 30 August filed a motion to amend their original 2015 complaint, along with the heavily redacted amended complaint. The banks, two of the original investors in the Zohar CLOs, have been doggedly pursuing a fraud case against Tilton, the founder and CEO of Patriarch Partners.

Following their analysis of millions of Patriarch documents obtained through discovery, the banks filed to amend their complaint based on additional evidence that they believe bolsters their case. The documents reviewed by the banks’ lawyers from Berg & Androphy included stock certificates, limited liability company agreements, internal spreadsheets, and tax reporting information, the complaint says.

Some of the losses that were incorporated as Tilton’s for tax purposes included a USD 30m loss generated by American LaFrance for Zohar II and III in 2010, and over USD 20m from Global Automotive Systems in Zohar II and III in 2008, the court documents show.

Additionally, for tax purposes, Tilton represented that many of the loans from the Zohar funds would never be paid back, according to the complaint. A 2012 presentation to the IRS, for instance, shows that some of the loans were described as “speculative” in order to “justify [Tilton’s] efforts to reduce any taxes owed,” the complaint says.

“None of these dire projections, or the analyses underlying those projections, were ever provided to Noteholders,” the complaint reads.

Tilton’s lawyers from Gibson Dunn have called the German banks’ attempt to amend their complaint a “desperate, eleventh-hour ploy involving new theories of alleged wrongdoing unmoored from their Complaint and so frivolous as to warrant sanctions.”

Judge Eileen Bransten denied Tilton’s motion to dismiss the fraudulent misrepresentation and concealment claim in the original complaint, but did dismiss the negligent misrepresentation claim. The first department of the New York State appellate division affirmed the judge’s order on appeal in February, 2017.

Onerous distributions

A version of the amended complaint also alleges the ways in which Tilton and Patriarch saddled some of the portfolio companies with debilitating fees in order to get money out.

Mobile Armored Vehicles, a company with only one employee and no operations, was charged USD 180,000 in management fees from 2008 – 2015. In 2015 – “after seven years of no actual operations” – the management agreement was amended and the annual fee was increased to USD 600,000, the complaint says.

And after American LaFrance, a maker of firetrucks, went out of business in 2015, one of the first things Tilton did was enter into a management services fee agreement with the non-operating successor company for USD 180,000 annually, the filing shows.

“In short, Defendants – using Zohar Fund monies and Portfolio Companies unwittingly owned by those funds – created two management agreements collecting USD 780,000 a year from two companies that had absolutely no operations.”

Tilton also “orchestrated” a payment of USD 44m to herself from Denali, Inc., through a redemption of preferred shares and a common stock dividend payment funded in part by monies from the Zohar funds, the complaint says.

“[I]n a six-month time frame, Tilton forced Zohar III to pay her over USD 44m in cash while increasing Zohar Ill's debt load for the Denali entities to USD 70m,” the complaint reads.

Finally, based on tax filings reviewed by the Plaintiffs’ lawyers, the complaint alleges that Tilton took sizeable equity distributions from the portfolio companies in the name of the Zohar funds. But those funds never flowed through to the Zohar lenders – they went instead to Tilton and Patriarch, the complaint says.

“Most significantly, a 2012 K-1 to Zohar III from Hussey shows a startling distribution of USD 65.36m to Zohar III in a year where Hussey made just over USD 10m,” according to the complaint.